Universities and the productivity challenge

With an emergency budget and an expectedly difficult comprehensive spending review looming on the horizon, Universities UK is preparing to make a strong case for why more investment in universities is needed to deliver on the government’s economic policy objectives. Our
report on the economic role of universities outlines some key reasons, touching upon how the higher education sector can help overcome the systemic weaknesses that are holding UK growth back.

Of all the challenges facing our economy at the moment, the UK’s dismal productivity growth record since the 2008 global recession (see figure below) has clearly emerged as the number-one concern for the incoming government, and with good reason. If productivity remains stubbornly low, then clearly our economy is not investing enough in its workforce and infrastructure, and is not innovating enough; the government has an essential role to play in turning this around.

Importantly, this focus on productivity growth can only be good news for higher education: as we argue in our report, universities have much to show for their role in helping make the economy more productive. Their activities have a huge impact on that element of productivity growth which is not accounted for by changes in the quantity of capital and labour (the so-called total or multi-factor productivity), but according to OECD data was responsible for an average 57% of UK labour productivity gains between 1995 and 2013 – here are two of the ways they do this:

Source: OECD, UUK calculations

By driving innovation through research and knowledge exchange: Innovation can come about in several ways, but one important vehicle for this is R&D activities. R&D can increase productivity in two ways: directly, by generating innovation, and indirectly, by speeding up the adoption of new technologies and ways of working (ie the so-called ‘absorptive capacity’ of businesses). In particular, publicly-funded R&D (three quarters of which is conducted in universities in the UK) generates large productivity gains that far outweigh the costs of research and are more widely shared and significant than those from business R&D. Haskel, Hughes and Bascavusoglu-Moreau estimate that every additional pound of public science spending permanently raises business output by 20p, and that’s even excluding any further impact from the private R&D spending that this investment attracts. Earlier research had also found that the impact of government and university R&D on productivity is around 30% higher than that of business R&D, and that university R&D increases productivity by more than R&D conducted in other publicly funded research institutes. This is not surprising given universities’ greater involvement in basic research, which means that their R&D activities are more orientated towards genuine innovation rather than imitation of competitors. Knowledge exchange has also been identified as a key productivity driver in its own right: according to a recent UK study, UK firms that source knowledge from, and/or cooperate on, innovation with universities can increase their total factor productivity (TFP) by 16.3% in production sectors and 11% in service sectors.

By strengthening human capital though higher education and skills training: Higher skills are an essential source of productivity gains in an advanced economy like the UK, and with negative demographic trends limiting the expansion of the workforce, their importance will only increase in the future. Our report mentions NIESR estimates suggesting that a 1% increase in the share of the workforce with a university degree raises the level of long-run productivity by 0.2-0.5%, but there is also plenty of other evidence suggesting that raising a country’s proportion of graduates generates large productivity gains at the regional and firm Graduate earnings are frequently used as a further proxy for productivity, as employers are willing to pay more to employ more productive workers; this evidence also shows that the earnings premium for first degrees has a substantial lifetime value of £250k for women and £165k for men, and has held up well despite a significant expansion of the system over the last decade.
Postgraduate qualifications also attract a large and rising wage premium.

Reversing the UK’s productivity fall is a very complex issue with neither quick nor universal fixes. Yet, if the government recognises the importance of boosting innovation and strengthening human capital for productivity growth, then making a bold investment in universities has to be a key step along the way to a more productive economy. The spending constraints implied by the government’s ambitious deficit reduction target don’t weaken the rationale for doing so. Rather, they strengthen it, as in a tight fiscal environment it makes even more sense for the government to prioritise spending that is highly productive – that is, spending that can expand the economy’s capacity to grow and help raise government revenues without tax increases, as is the case for investment in the higher education sector.

Today saw a lot of media coverage and fanfare around a new 'degree course ranking' system. In reality, this was simply the launch of a long-awaited consultation on how to implement a subject-level version of the Teaching Excellence Framework.